The earlier post on a simple momentum strategy ignored transaction costs and taxes. Typically, these are added to backtests where gross profits are high enough to consider them for further analysis. However, one of readers requested that we add these costs to get an idea of their effect on returns.
To keep things simple, we assumed a 25bps net transaction cost and a 10% tax on gains. The tax part is a bit tricky so we ran the analysis with some simplifying assumptions. Follow the github link to the code if you are curious.
Running with these assumptions, transaction costs and taxes lopped 82% off gross returns over Jan 2005 through June 2018.
What kills you are the taxes, not the transaction costs. There were only 17 trades throughout the period. It is the 10% tax on gains that ruins the compounding.
Code and other charts are on github. Look for ones with a ‘tx’ in the suffix.